Saving for your kids' education

Your education saving options

All parents know school and university fees can be expensive. It may seem like you'll have to feed the kids gruel for the next 18 years just to send them to your preferred schools, but saving for education shouldn't send the whole family to the poorhouse. Let's look at your options.

How much is it going to cost me?

Estimate how much you'll need based on how old your kids are, whether you want to send them to private or government schools, and whether you're saving for their primary, secondary or tertiary education – or all three. Primary schooling will cost less than secondary and tertiary schooling.

Start saving early

The best time to start saving is when your child is born or even earlier. If that's not an option, then like any other long-term savings goal – the best time to start is now. Make a budget and decide how much you can put aside each week. Increase the amount each year to account for inflation.

There are a few ways you can achieve your savings goal. It could be as simple as setting up a direct debit from your account and deducting a weekly amount into education savings. You could also make lump-sum contributions, such as your annual tax refund.

Ways to save for education

The key factors to look at when selecting your savings strategy are:

performance

risk

tax rates.

The options on offer will depend on your situation, but these are the main ones to consider.

Mortgage

Paying off your mortgage as quickly as possible saves you interest and frees up your cash. Make sure your mortgage has a redraw facility with low or no fees, or an offset account, so that you have access to the money if you need to draw on it for education expenses.

Pros

The interest saved on your mortgage, depending on your interest rate, is an after-tax return which can be hard to beat with any other investment.

Cons

You need to be disciplined and not access the money for other expenses.

Salary sacrifice

Contribute extra superannuation to make sure your retirement is taken care of, even after the school fees hit.

Pros

Tax advantages: Extra contributions up to a cap are taxed in the super fund at a maximum rate of 15%. Investment earnings are taxed at 15% and once you are 65 years old you can access your super tax-free (60 if retired).

Cons

This only works if, once you stop contributing to super, you have enough money freed up to pay the education costs out of your normal cash-flow.

Money in super is locked away and you can't access it early.

Insurance bonds

Insurance bonds work like a managed fund, and are available from a range of financial institutions allowing a range of investment strategies.

Pros

Can be set up in your or your child's name. Some insurance bonds allow you to nominate an age when the ownership will transfer to the child.

Tax advantages: if you hold the investment for ten years and contribute no more than 125% of last year's contribution each year you won't be taxed for the earnings. Earnings will get taxed within the insurance bond at the company tax rate of 30%. If the funds are accessed in the first eight years then all earnings are assessable. If accessed in years eight to nine then two thirds (2/3) of the earnings are assessed and if accessed in the ninth year but before the tenth then one third (1/3) is assessed. So, if you are on a lower marginal tax rate than 30% you will receive a credit. If you are on a higher marginal tax rate you will need to pay additional tax if you access the earnings before ten years.

Cons

Entry, management and other fees may apply.

Education savings plans

Education savings plans (ESPs), which offer a tax-free investment for education, sound like a good idea, but it's critical to find out what kind of leverage these have over your money.

ESPs are designed for saving for tertiary education, as the earnings on investments are paid directly to the nominated child. These earnings are taxed as income for the student. Income up to $16,000 is usually tax-free for students over 18, however high tax rates apply to children under 18 – any interest from $416 to $1307 is taxed at 66%. If a child has interest income of more than $1307, the whole amount is taxed at 45%.

So while your child is under 18 it's better to only withdraw contributions to help with education expenses, as you can do this tax free, however it will reduce the earnings. Earnings are taxed at the company rate of 30%, but if the earnings are used for a broad range of education expenses, the ATO refunds all tax paid on them back to the fund.

Family trust

A family trust may be a good option if you have a large sum of money available. Although you'll need specialist financial advice and there are administration costs, a family trust can help you to legitimately distribute investment income and take advantage of lower marginal tax rates for certain members of the family.

Savings accounts, funds and shares

Investments such as online savings accounts, managed funds and shares can be a way to set money aside for your children's education. However, consider the flexibility of the investment: online savings accounts are readily accessible, but you'd want a long-term investment timeframe for an investment in managed funds or shares. As you begin to approach the time you'll need access to the funds, consider moving the money into a more accessible investment.

Pros

Can be started at any stage and gives you freedom of choice for your investment strategy.

Can be suitable for people on a lower marginal tax rate.

Cons

Earnings will be taxed at your marginal tax rate, so it might be a good idea to hold the investment in the name of the parent with the lowest marginal tax rate. Half of all capital gains are tax free; the other half is taxed at your marginal tax rate. Tax concession such as franking credits may apply. Minimum investment amounts and costs such as brokerage, or entry and ongoing management fees, may also apply.